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Investment Planning > Key Principles of Investing > Flashcards

Key Principles of Investing Flashcards

1
Q

Where are assets listed on a company’s balance sheet?

How are they valued?

A

Left side

Fair Market Value

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2
Q

What are the 3 categories of assets when listed on a balance sheet?

A
  1. Cash/cash equivalents
  2. Investments
  3. Personal use assets
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3
Q

What is a NOW account?

A

Negotiable Order of Withdrawal

-Interest paying checking account

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4
Q

What are Money Market Mutual Funds?

A

Not bank products (not FDIC insured)

-Short term low risk securities
-Taxed at ordinary income rates

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5
Q

True or False

Interest earned on Treasury Bills is included in federal, state, and local gross income

A

False; federal only

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6
Q

What is Commercial Paper?

A

-Type of cash/cash equivalent

-Short term unsecured debt issued by corporations

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7
Q

What are Equity Securities?

A

Investments

Shares of ownership in a corporation

STOCKS

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8
Q

What are Fixed Income securities?

Coupons?

Principal?

A

Fixed Income Securities are debt obligations issued by corporations, governments, and government entities

Coupon is interest paid

Principal is original loan repaid at the date of maturity

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9
Q

True or False

Natural Resources have historically had a low correlation with domestic stocks (ie do not increase/decrease in value at the same time)

A

True

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10
Q

What are commodities?

A

Raw materials

e.g. grain, oil, cattle, gold, etc.

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11
Q

What the heck are derivatives?

A

-Basically contracts betting on the value of another thing (e.g. commodity, stock price, etc.)

-Not direct trade

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12
Q

Describe what “yield” means

A

A type of return. It’s the flow of cash from an investment

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13
Q

In terms of yield, stocks have ____ / bonds have ____

A

dividends

interest

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14
Q

What is Total Return formula?

A

Yield of investment + Growth of investment = Total return

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15
Q

2 ways to calculate average return?

A
  1. Arithmetically
  2. Geometrically
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16
Q

Formula to calculate Holding Period Return

A

(Sales Price + yield - purchase price) ÷ purchase price

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17
Q

Investment Risk is driven by these 2 forces

A

1 Systematic Risk
2 Non-systematic Risk

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18
Q

What is the formula for Total Investment Risk?

A

Systematic risk + Non-systematic Risk = Total Investment Risk

19
Q

Generally speaking, what is systematic risk?

A

AKA Non-diversifiable risk

Broad macro-economic factors influence this type of risk

(war, pandemic, inflation, interest rates, etc.)

20
Q

The P.R.I.M.E. acronym for systematic risk

A

Purchasing Power Risk (inflation)
Reinvestment Rate Risk (rates decreased since original investment; not worth reinvestment)
Interest Rate Risk (changes value of security)
Market Risk (risk in overall market; e.g. war)
Exchange Rate Risk (currencies)

21
Q

How do you arithmetically calculate a rate of return (arithmetic mean)?

What is the major con?

A

Basically find average rate by adding and dividing

The problem is this method of finding an average rate of return hides volatility

22
Q

Generally speaking, what is non-systematic risk?

A

Can be diversified away;

specific to business, industry, security, etc.

23
Q

5 common Non-systematic Risks

A
  1. Management Risk - bad business strategy/leadership
  2. Financial Risk - bad books (eg too much debt)
  3. Default Risk - not paying up
  4. Liquidity Risk - no buyers when time to sell
  5. Concentration Risk - all eggs, 1 basket
24
Q

What does “beta” mean?

A

Beta is the measure of the volatility of a particular security’s rate of return or price relative to overall market

.3 = less risky than market
1.0 = good & in line with market
3.0 =RISKY

25
Q

True or False

Beta is the measure of systematic, non-diversifiable risk

A

True

26
Q

True or False

Investments with large standard deviations are considered riskier than those with small standard deviations

A

True

27
Q

What does covariance mean?

A

The absolute measure of the extent to which two assets move together

28
Q

Covariance formula

A

ab = Pab x σa x σb

ab = covariance
Pab = correlation coefficient
σa = standard deviation a
σb = standard deviation b

29
Q

True or False

A positive covariance means the securities’ returns tend to move together;

negative covariance means the returns offset one another

A

True

30
Q

What is the “correlation coefficient?”

A

Measures how securities move against each other

31
Q

Correlation Coefficient Formula

A

Pab = covarianceab ÷ (σa x σb)

Pab = correlation coefficient
covarianceab = covariance
σa = standard deviation a
σb = standard deviation b

32
Q

How is the coefficient of determination denoted in a formula?

A

r²

33
Q

What does the coefficient of determination do?

(2 things)

A
  1. Builds upon the correlation coefficient
  2. Measures the variance of returns in a portfolio in relation to a market
34
Q

How do you find the coefficient of determination?

A

Take the square of the correlation coefficient

35
Q

True or False

Beta is considered an appropriate risk measurement tool ONLY when r² is higher than .3

A

False; use beta when r² is higher than .7

36
Q

What is coefficient of variation?

A

The measure of relative variability used to compare investments with widely varying rates of return and standard deviations

37
Q

How do you calculate a security’s coefficient of variation?

A

Divide Standard deviation by its mean

38
Q

Describe “risk premium”

A

It’s the additional compensation investors receive for taking risk

(eg cheaper stock price)

39
Q

What is the Bond Horizon Premium?

A

The excess return bond investors expect to earn on long-term US government issues over their shorter term Treasury Bills.

40
Q

What is Equity Risk Premium?

A

The excess return investors expect to earn in stocks over risk-free securities such as Treasury Bills

41
Q

Marketability refers to…

A

The ease or difficulty with which a security can be resold in the secondary market

42
Q

What is a marketable security?

A

A security for which there is an active market in which the security can be sold

(eg stock; NOT real estate)

43
Q

What is liquidity?

A

The ease with which assets can be quickly converted to cash without a substantial loss in value

Investment Planning (14 decks)

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